The most important number of the month came out. US inflation. And it came in hotter than everyone expected.
But the most striking thing wasn't the number itself. It was what happened immediately afterward. Before the announcement, the market was pricing in a 21.6% probability that the FED would raise interest rates in October. Shortly afterward, that probability jumped to 43.7%.
Yes, you read that right. It doubled within minutes.
And all this just two weeks before the FED meeting.
WHAT THE NUMBERS SHOWED
The CPI, or Consumer Price Index, rose to 3.7% year over year in September. In August, it was 3.4%. Analysts had expected 3.6%.
"Come on, one tenth of a percentage point? All this fuss over one tenth?" you might be wondering.
The truth is that the problem isn't just that tenth of a percentage point. It's the core CPI.
What's that? In simple terms, core CPI measures inflation excluding food and energy. In other words, we remove the items that fluctuate sharply from month to month to get a clearer picture of the underlying trend in prices.
Core CPI rose to 2.6%, up from 2.4% in August. Expectations were for 2.5%. It increased by 0.3% during the month, while the market had expected 0.2%.
In other words, both headline inflation and core inflation came in above expectations. And that's what worried the market.
THE CULPRIT IS GASOLINE
Let's look at where this increase came from.
The main culprit is gasoline. It rose 9.1% in just one month. Compared with last year, it's up 34.2%. Gasoline alone accounts for approximately 43% of the monthly increase in prices.
And as if that weren't enough, overall energy prices are up 20.4% year over year. Airline tickets? Up 22.4%.
Brent crude is hovering around $106 per barrel. And the Houthis struck an Aramco building in Saudi Arabia. So energy prices don't look likely to calm down anytime soon.
Of course, there's a big "but."
If gasoline were the only problem, the FED could say, "Okay, this is temporary." However, housing costs rose 0.4% during the month. And that has nothing to do with the war or oil prices.
This is where things get interesting. Food prices remained unchanged, with no increase at all. In other words, the pressure didn't come from the supermarket. It came from energy and rents.
And here's another point worth mentioning. Headline inflation has been above core inflation every month since March. It reached 4.2% in May.
And who's paying the price? Ordinary people. Real hourly earnings, meaning wages adjusted for inflation, fell 0.7% compared with last year. In short, prices are rising faster than wages.
HOW THE MARKET REACTED
The reaction was immediate.
The yield on the US 10-year Treasury rose by 9 basis points to 5.306%. The 30-year yield climbed to 5.612%.
"And why should I care about bond yields?" you might be wondering.
Because when bonds offer yields above 5%, many investors start asking themselves, "Why take risks with stocks when I can earn that much with relatively little risk?"
This puts pressure particularly on technology stocks, whose valuations depend on the profits they're expected to generate in the future.
But the most important development was the one we mentioned at the beginning. According to CME FedWatch, the probability of an October rate hike rose from 21.6% to 37.1%.
In other words, within minutes, the market completely changed its outlook.
THE FED'S DILEMMA
To understand this, we need to remember where things stand.
On September 16, the FED had already raised interest rates by 0.25 percentage points, bringing them to a range of 3.75% to 4%. Yes, a RATE HIKE, not a cut. And the minutes from that meeting showed that most officials believe another rate hike will probably be needed before the end of the year.
In fact, Williams, the president of the New York FED, said he expects another rate hike this year, but not in 2027.
And that brings us to the October 27-28 meeting. September's CPI report was the last inflation reading before that meeting.
Now, you might ask: does this mean the FED will definitely raise rates? No. The market is pricing in a 43.7% probability, which is still less than a 50% chance.
There's also one important detail. The FED targets 2% inflation, but it doesn't use CPI to measure it. It uses a different index, the PCE. So the CPI reading of 3.7% cannot be directly compared with the FED's 2% target.
Nevertheless, the message is clear. Inflation hasn't had its final say yet.
